Buffett doesn’t worry about the market crashing, and neither should you

Right now, everywhere you look, someone is forecasting the end of the market rally, the beginning of a 2008-style bear market, or an airship crashing. There is a certain element of the tail wagging the dog here. Eventually, so much media hype about a market crash will result in, yes, a market crash. However, it pays to follow the best, and in this case the best investors are not selling, nor are they worried about the market collapsing. Warren Buffett is still adding to his core holdings, and remember: Buffett is not afraid to stay out of the market when…

Right now, everywhere you look, someone is forecasting the end of the market rally, the beginning of a 2008-style bear market, or an airship crashing. There is a certain element of the tail wagging the dog here. Eventually, so much media hype about a market crash will result in, yes, a market crash.

However, it pays to follow the best, and in this case the best investors are not selling, nor are they worried about the market collapsing. Warren Buffett is still adding to his core holdings, and remember: Buffett is not afraid to stay out of the market when it is overheating. The oracle of Omaha famously proclaimed during the ’70s that he could see no opportunities and the market was overvalued. Having said that, Buffett has been changing the structure of his portfolio, and it is easy to see why.

Berkshire Hathaway has all but liquidated its positions in Mondelez International (NASDAQ: MDLZ) and Kraft.This comes as the consumer goods sector becomes highly overvalued in comparison to the rest of the market. In addition, Mondelez has been losing some of its dominance over the industry — Buffett sold Procter & Gamble and Johnson & Johnson for the same reasons.

Losing the edge

The Kraft-Mondelez split removed two key Buffett buying points from the two companies: size and moat. While each company individually is still valid, with its own product moat and economies of scale, the combined company had a much bigger moat and economies of scale. Moreover, Mondelez is now in direct competition with industry giant Nestle, which is not a situation that Buffett would like to be exposed to. This is especially true considering Nestle’s dominance across the entire food market — not just confectionery items.

Separately, Mondelez and Kraft are weak. Mondelez no longer has the fire-power to compete internationally, and Kraft’s domestic operations no longer have the international operations to supplement growth, so investors have lost out on both sides after the split.

Furthermore, Mondelez has lost another moat; at 23 times forward earnings, the company looks expensive in comparison to peer Nestle, which trades at only 17 times forward earnings. Considering Nestle has a much bigger global footprint, it should have the premium here. Moreover, Mondelez has been losing cash at the rate of US$2 billion a quarter for the last two quarters, and revenue fell in Q2 from Q1, highlighting the aggressive competition in the industry.

Value elsewhere

Still, Buffett is finding value in other sectors of the market. General Motors (NYSE: GM) is one of Berkshire’s recent adds. The giant conglomerate nearly doubled its stake in the auto manufacturer during the second quarter — certainly a vote of confidence for the auto producer.

GM has been on a roll this year, with the stock up 23% year to date. However, as usual, Buffett’s play is longer-term, and it’s easy to see why.

The auto recovery is well underway within the U.S., with both Ford and GM reporting strong sales. Additionally, the government is winding down its stake in the manufacturer, and recent actions by management to turn the company around have been very successful. Furthermore, GM is gaining more support from media, and reviews of new vehicles released in recent months have been terrific. Old, dysfunctional brands have been disposed of, and the company is no longer funding oppressive healthcare liabilities.

Moreover, in China, GM’s business is strong, while Ford flounders in that region and Europe. Analysts expect GM’s EPS to hit US$4.50 by 2014, up from US$3.15 during 2013, indicating P/E ratios of eight and 11.4, respectively. Although Buffett is generally not concerned with forward estimates, the company has a key moat, which in this case is wide and deep; there are not many companies that can compete with GM’s global dominance.

Unloved value

Elsewhere, Berkshire initiated a small position in Suncor Energy (NYSE: SU) . I have commented on Suncor’s value creation and future outlook before, so here I’ll analyse the firm in Buffett’s style. Firstly, Suncor has more than three decades of oil reserves at current production rates. That is more than the reserves of ExxonMobil, so the company is set for the long term.

Moreover, Suncor has a wide moat, as it is one of the industry leaders in oil-sands production and has international offshore oil-production facilities to boost cash flow. The company has achieved a three-year return on capital employed of 5.2%, or closer to 10% on an operating-income basis. It has returned 10% of the stock price to investors since 2011, and management is investing for the long term. They are only spending cash from operations on capital expenditures, with the rest being returned to investors — signs of fiscal prudence and a strong management team. The company also recently unveiled an additional US$2 billion buyback funded by operating cash flow.

What’s more, even if the company does not spend to expand existing operations, there is no reason why shareholder returns cannot continue at the rate of 10% every two years based on current operating cash flows. This formula indicates a compounded total return of 100% within 7.2 years without any share price appreciation.

Buffett is not afraid of a market crash. The Oracle of Omaha is still putting cash to work, finding deals in the market and not panicking. You should be doing the same.

The Australian Financial Review says “good quality Australian shares that have a long history of paying dividends are a real alternative to a term deposit.” Get “3 Stocks for the Great Dividend Boom” in our special FREE report. Click here now to find out the names, stock symbols, and full research for our three favourite income ideas, all completely free!

Free report names the 3 dividend shares The Motley Fool's crack team think you should buy now for 2019 and beyond.

Sign up now for instant access to your copy of this free report.

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe at anytime. Please refer to our Financial Services Guide (FSG) for more information.

Stay Connected with the Fool

This Service provides only general, and not personalised financial advice, and has not taken your personal circumstances into account. The Motley Fool Australia operates under AFSL 400691. For more information please see our Financial Services Guide. Please remember that investments can go up and down. Past performance is not necessarily indicative of future returns. The Motley Fool Australia does not guarantee the performance of, or returns on any investment.